Working Paper: NBER ID: w1603
Authors: Robert P. Flood; Robert J. Hodrick
Abstract: Typical evaluations of the choice of exchange rate regime employ a criterion function that depends on the real performance of the economy, and they focus on regimes that are expected to last indefinitely. This latter feature is strongly contradicted by the transitory nature of actual regimes.This paper extends the recent literature on collapses of fixed exchange rate regimes with exogenous real sectors to examine how the predictions of two popular models for the determination of some real economic variables must be modified when agents rationally perceive that the fixed rate regime will be transitory. The models studied are simple stochastic versions of the models in Dornbusch (1976) and Flood and Marion (1982).
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JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| perception of regime permanence (P26) | variance of real output (E23) |
| temporary fixed exchange rate regime (F31) | higher output variance compared to permanently floating regime (E39) |
| domestic credit process (E51) | stability of fixed exchange rate regime (F31) |
| government's policies (H10) | likelihood of regime collapse (P27) |
| perceived stability of exchange rate (F31) | conditional variance of output (C29) |
| expectations of regime collapse (P27) | increased volatility in real output (E39) |
| agents' expectations about future stability of the regime (D84) | wage-setting behavior (J31) |